Mending the Global Trade System in the Pandemic Age
Dr Mohammed Faiz Bin Shaul Hamid
In an era where states have lost some power and influence in determining trade and investment decisions to global firms, the global economy is confronted with rising protectionism that appears to be the penultimate tool available to states that are losing control of the complex fragmented production networks that form the Global Value Chains (GVCs). The situation is exacerbated with the current ongoing global pandemic. Although economists have long shown that trade liberalization has positive welfare effects, some preconditions of such trade liberalization are today not entirely controlled by states as global firms play an increasingly more important role in the global economy and the limited policy space available to create a fair, equitable and transparent global trading system.
Globalization and free trade agreements (FTAs) has allowed states to promote trade and investment in a more coherent approach, however, there are limitations to such trade integration and investment policies if it is not coupled by the needs and requirements of the global economy especially with the supply and demand shock during the global pandemic that may completely question the use and effectiveness of FTAs. The rise of FTAs since 1990s to mega FTAs such as the partly failed Trans Pacific Partnership Agreement (TPPA) and the ongoing negotiations on Regional Comprehensive Economic Partnership (RCEP) for more than seven years are testaments that trade liberalization efforts through FTA despite the increase in chapters and coverage of industries has not addressed the concerns of the majority states. What is prevalent in FTAs is that every state is trying hard to find a “one size fits all” approach, while at the same time instead of complementing each other in a trade agreement, states compete further in the same industries and ultimately most countries have similar tools of protection, apply reciprocal tariffs and mirror each other in their investment policies.
Both trade liberalization and investment promotion efforts have peaked to a level where it has lost appeal to global firms using either one or another as a strategic decision to locate its suppliers and manufacturing plants. This is evidenced by the low level of preferential tariff utilization even though most tariffs are reduced to zero or near zero percent and the similarities between countries in offering the same investment incentive package that allows global firms to shop for the best package.
Since the start of the Covid-19 pandemic, a new trend emerged out of desperation with unilateral policies that further protect industries and supplies without any regard to cross border trade and investment arrangements that were in place. In a survival mode, most countries without much global leadership on the global trading system opted “trial and error” policies that seem to slowly gain traction as many countries are restarting their economic activities.
The crossroad that we are in today is quite worrying. Even if countries restart the economies to the full swing and with multiple incentives and handouts from the governments, economic activity that is profoundly dependent on manufacturing at the heart of it will not recover as easily as expected. The uncertainty brought by the ongoing pandemic coupled with the distrust in the global trading system may result in an even slower recovery. Suppliers and manufacturers for a fact are already fragmented in a global production network. Multinationals have also spent billions to invest in the most cost-efficient setting that we view as a global value chain. They also took years to build the local capacity and the idea of reshoring, which is an extreme end of protectionism, may only be a concept or forced for certain crucial industries with high incentives from the government. In a world hit by the global pandemic, demand slack will not be able to compensate the rising cost of reshoring activities.
The solution to this problem begins with looking at underlying challenges of the global trading system. The global trading system needs to create a “win-win” situation for both firms and states which seems to run out of policy tools to govern the complex GVCs that are spread in different parts of the world. Trade and investment policies that are centred around broad industries should be shifted to product based policies, considering specialization and avoiding industry wide policies. As the world is also moving towards the fourth industrial revolution, it is expected to bring about more disruption to the global trading system as it is and therefore, policy tools such as tariffs and rules of origins should be replaced with more flexible tools such as volume based tariffs, tariff pass through mechanism and ownership based tariffs. This requires a better understanding of product level transactions between firms beyond between borders and innovative approaches especially with the use of big data and artificial intelligence.
Since global firms and multiple states govern a GVC for any industry, global industry coalitions that includes multi states, global firms and institutions for every industry should be established to determine industry standards, cooperation, trade and investment policies. The global industry coalition would also need to address development goals as well as mutual benefits for all actors concerned in the global coalition. At the same time, the global industry coalitions should also be entrusted to support the least developed states that are part of the global industry.
The huge disparity between firms that are state owned firms and global firms also calls for a middle ground policy that fits more rather than fits all. In a globalized world with fragmented production networks controlled by different types of firms across the world, it is difficult to find a “one size fits all” policy, but a “one size fits more” policy which covers the majority consensus on trade liberalization, investment, labor, environment and intellectual property.